Flight to safety versus fight for returns

After 2021’s boom comes 2022’s bust, leaving global public funds looking for alternatives and safe havens

The 2022 edition of OMFIF’s Global Public Pensions paints a clear and stark picture of the fundamentally changed investment challenges facing the world’s biggest asset owners.

This report covers global public pension and sovereign funds with total assets of over $27tn. Most had a remarkable year in 2021, riding the wave of rising markets to post stellar returns. Assets at the top 100 pension funds rose by 17%. Assets at the leading 50 sovereign funds did even better, rising 23%, in part helped by inflows in commodity-rich nations.

The era of quantitative easing since 2009 made the rich in society richer – and it clearly had a similarly positive impact for public asset owners. Even while holding on average over 40% of their assets in fixed income at negligible yields, other asset classes pushed their performance to new heights.

That era came to a crashing halt in 2022. Rising inflation, interest rate hikes to combat soaring prices and the impact of Russia’s war in Ukraine have turned markets on their head. In the US, both bond and equity markets fell off more than 15% in the first 11 months of 2022. And asset owners don’t anticipate that these conditions will improve any time soon.

For the first time, this year’s GPP contains a bespoke survey of the investment plans of global public funds worth over $3tn combined. They expect a period of stagflation. The global economic slowdown and persistently higher inflation are their two main concerns. In this environment, how do they plan to protect the gains of recent years and generate positive returns?

Figure 1. Risk of stagflation looms large for global public funds

What are the most important economic challenges affecting your investment approach over the next 12-24 months, Share of respondents, %

Source: OMFIF GPP survey 2022

As is typical in volatile times, a flight to safety is apparent. Global public funds will be net sellers of public equity and some higher-yielding fixed income assets. They will put their money to work, reducing cash holdings. They will retreat to the stronger currency blocs, with dollar holdings rising appreciably and the euro benefiting as well.

But – where their mandates allow – they will also invest more in alternative assets. Top of the list of their allocation targets are inflation hedges such as real estate and infrastructure assets, as well as inflation-linked government bonds. They will seek to drive returns with more investment in private equity, hedge funds and commodity-related assets.

Figure 2. Funds becoming more active and more conservative

Over the next 12-24 months, do you expect to increase, reduce or maintain your allocation to the following assets? Share of respondents, %

Source: OMFIF GPP survey 2022

There are risks in this approach – many of these are less-liquid assets and funds will want to avoid any liquidity crunches in uncertain times. Sooner rather than later, the attraction of improved fixed income yields may outweigh the pressure to avoid assets that are falling in price. Our survey reveals many other important findings. For the first time in recent memory, allocations to the renminbi are set to fall. Despite market uncertainty, many asset owners will continue their move away from domestic assets to more foreign investments – often with the help of external managers. Global public funds remain committed to investing in more sustainable ways, with a particular focus on renewables, transition finance and green bonds.

Figure 3. Actions match talk in drive towards sustainable finance

How is the green transition affecting your investment plans? Share of respondents, %

Source: OMFIF GPP survey 2022

And improving their operating models is very much top of mind. More than 80% of respondents say a core priority is to improve their data systems. Efficient operating models, and clever use of data, will be more important than ever as global public funds face a new and difficult era.

Clive Horwood is Deputy Chief Executive Officer and Managing Editor of OMFIF.

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